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Carbon TradingAuthor: Partha Das Sharma (Email:sharmapd1@gmail.com
 
)Website:http://saferenvironment.wordpress.com 1
Carbon trading is market based tool to limit GHG emissions – effectivefor management of Carbon footprint
***
Author: Partha Das Sharma (E.mail:sharmapd1@gmail.com
 
)Website:http://saferenvironment.wordpress.com ***1. Introduction – 
Carbon emissions into the earth’s atmosphere have resulted in drastic climatic changes.In 1997, in Kyoto, developed Industrialised countries pledged to reduce the production of greenhouse gases which contribute to Global warming by a minimum of 5% by 2012,compared to a 1990 baseline. The Greenhouse Gases which include Carbon di-oxide(CO), Methane (CH4) and also other oxides on account of incomplete combustionsubstantially disturb the balance of the heat in the earth’s atmosphere leading to warmingof the atmospheric temperature which is called as Global Warming and is considered amajor threat to life on earth.Carbon trading is the idea is to develop a mechanism to allow market to drive industrialand commercial processes in the direction of low emissions. Working in that direction,Governments of various countries are trying to come up with, a trading mechanism wherecompanies gain a monetary benefit out of polluting the air less. Kyoto protocol’s goal isexactly that. The idea is to divide the whole world into two, one who can afford makingchanges to their existing infrastructure and the ones who cannot. As everybody is polluting, be it a developed country or a developing country, the financial aspect has to be kept in mind. All developed countries will have to cut down their emissions by some x percentage or else they pay heavy fines. Now, one way of measuring how much they are polluting the air less, is by clean each tonne reduction of CO2 a unit and a company mustown those amounts of units at the end of every period.Carbon trading, sometimes called emissions trading, is a market-based tool to limitGreenhouse gas (GHG). Emissions trading aims at efficient investments in emissionreduction. In other words, carbon credits are a key component of national andinternational emissions trading schemes that have been implemented to mitigate globalwarming. They provide a way to reduce greenhouse effect emissions on an industrialscale by capping total annual emissions and letting the market assign a monetary value toany shortfall through trading. The carbon market trades emissions under 
cap-and-tradeschemes
or with
credits
that pay for or offset GHG reductions.
2. Mechanism of Emission Trading System and functionalities -
 In its simplest form, a “cap and trade” program has two main components. An emissionstrading scheme (ETS) attempts to put a price on the emissions of a targeted gas, so asto make firms internalize environmental resources in their business decisions. A cap is setfor aggregate emissions in the system. Allowances are then issued that allow their holdersto emit a certain quantity of the targeted gas. The sum of all allowances issued is equal tothe overall cap. Firms are then allowed to trade these allowances. If it is cheaper toreduce emissions than buy an allowance, then a firm will become a net seller; conversely,
 
Carbon TradingAuthor: Partha Das Sharma (Email:sharmapd1@gmail.com
 
)Website:http://saferenvironment.wordpress.com 2if it is cheaper for a firm to buy allowances than reduce its emissions, then it becomes anet buyer.As mentioned above, the first component is a ceiling or “cap” established on aggregateair emissions, which typically declines over time. This declining or “phasing-in” of thecap sets a maximum limit on emissions and imposes a legal obligation that ensures thespecific longer-term environmental goals are met. By phasing in the cap over multiple periods, companies regulated by the program can begin investing in compliance whilereduction requirements are less aggressive, and then accelerate their strategies as the capis ratcheted down over time. Emitters within economic sectors covered by the programare responsible for reducing their emissions to comply with typically annual emissiontargets.Without the legal certainty of future emission levels afforded by the hard “cap” theenvironmental objectives of the program may not be achieved. In contrast, programs thatuse emissions fees or taxes (e.g. a carbon tax) impose no legal obligation on the number of tons that can be emitted and thus provide no assurance that specific emissions targetswould be achieved.The second component in a cap and trade program is a market-based emissions tradingsystem. An emissions trading system, which has become synonymous with the “trade”component in a cap and trade program, is created and regulated by government and provides for the use of emissions permits or “allowances” as a form of compliance withthe stated emissions caps. Each allowance is the equivalent of one ton of emissions.Companies whose emissions are greater than their allocation or share of the cap are ableto purchase allowances to meet their reduction goals. Companies that reduce their emissions more than required by their allocation are able to sell the excess allowances inthe open market or to other companies interested in purchasing them. The tradable permitmarket that ensues from this structure provides clear price signals regarding the value of emissions reductions and allows rational economic decision making and risk managementtechniques to govern capped sources’ emissions management and control decisions.Several other notable cost containment mechanisms help to create an even more cost-effective emissions trading system. First is the concept of “banking” emissionsallowances. Banking allows companies that are regulated by the program to carryforward unused allowances from previous compliance years and use them to meet futureyears’ compliance goals. Banking has proven to be an important mechanism in reducingcompliance costs because it provides companies with the flexibility of making additionalemissions reductions earlier than required in order to avoid some future requiredreductions when the costs of compliance are much higher.
“Borrowing”
, another cost containment mechanism, allows companies to borrowallowances from future compliance periods and submit them for current-year compliance periods. Borrowing was first introduced in the European Union’s Emission TradingSystem as a means to both reduce compliance costs and dampen allowance pricevolatility. The creation of a “strategic reserve” of allowances is another cost-containment
 
Carbon TradingAuthor: Partha Das Sharma (Email:sharmapd1@gmail.com
 
)Website:http://saferenvironment.wordpress.com 3mechanism by which allowance price volatility and compliance costs can be mitigated.The concept of a strategic reserve has been incorporated into several recent U.S. climate bills. The reserve would help stabilize market prices by injecting additional allowancesinto the market when market prices reached the reserve’s minimum auction price.Another important mechanism of an emissions trading system, particularly with regard togreenhouse gases emissions, is the concept of an
“offset”
. Offsets represent actual,verified emission reductions made by greenhouse gas emitting sectors that cannot practicably be included under the cap. Examples include the U.S. agricultural andforestry sectors and certain sectors within developing countries. By utilizing marketincentives, qualifying projects are able to reduce their overall emissions at a relativelylow cost. Offsets are important because companies regulated by an emissions cap are ableto purchase offset credits and use them towards their own compliance goals, generally ata cost lower than either purchasing allowances or pursuing more costly internalabatement options. Most economists and analysts expect that offsets will be a low-costway for companies to meet their compliance goals by allowing them to access equivalentlower cost reductions outside of the cap, while achieving the same aggregate reduction of emissions. Offsets are a viable part of greenhouse gas emission programs since the effectsof GHG emissions are the same wherever they are emitted in the world, unlike the casefor the local or regional pollutants such as SO2 and NOx. Offsets also provide a valuabletemporal bridge, allowing early emissions reductions objectives to be met at reasonablecost while new clean energy technologies are developed and available for commercial-scale deployment.International offsets are also particularly important because of their relatively low costand, critically, their role in providing incentives for the sustainability of tropical rainforests and the promotion of low-emitting technology in developing countries.
3. Discussion on cost effectiveness and environmental benefits of Cap-and-tradesystem – 
* The U.S. Acid Rain Program is the most mature example of how a cap and trade systemworks to both reduce the cost of compliance and also meet and even exceedenvironmental targets.* The European Union Emission Trading Scheme is the cornerstone of the EU’ssuccessful effort to meet its emissions reduction obligation under the Kyoto Protocol.While the ETS cap nominally covers only approximately 40% of the emissions from theEU, the EU carbon market, particularly the flexibility provided by the use of offsetsthrough the Clean Development Mechanism, has allowed the EU member-states to useinternational offsets to achieve reductions from sectors not covered by the trading program.
4. Summary of mechanism of Carbon Cap-and-Trading and related aspects – 
Cap-and-trade schemes are the most popular way to regulate carbon dioxide (CO
2
) andother emissions. The scheme's governing body begins by setting a
cap
on allowableemissions. It then distributes or auctions off 
emissions allowances
that total the cap.Member firms that do not have enough allowances to cover their emissions must either 
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